Economic Substance Regulations in the UAE
The UAE has long been held at fault for being non-cooperative as far tax imposition and collection from businesses is concerned. Reviewed by the EU, UAE’s tax framework was included on the EU’s list of non-cooperative jurisdictions for tax purposes. Being featured on the EU’s blacklist is obviously detrimental to the UAE’s business interests. Therefore, in response to the blacklist and as part of its obligation as a member of the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS) to put an end to tax avoidance strategies that exploit gaps and mismatches in tax rules to avoid paying tax, the Economic Substance Regulations was introduced. Issued on 30th April 2019, the ESR was introduced to ensure that companies carrying out certain specified activities in the UAE function in compliance with their tax obligations and do not indulge in tax avoidance strategies.
Applicability of the Regulations
The Regulations apply to UAE onshore and free zone companies, branches, partnerships, and other UAE business forms (referred to as Licensees) that carry out any of the Relevant Activities mentioned in the ESR. Relevant Activities include:
- Banking Businesses
- Insurance Businesses
- Investment Fund Management Businesses
- Lease-Finance Businesses.
- THeadquarter Businesses.
- Shipping Businesses.
- Holding Company Businesses
- Intellectual Property Businesses
- Distribution and Service Centre Businesses
An Economic Substance Test will be implanted for each relevant financial period where the Licensee earns income from a Relevant Activity. The Economic Substance Test requires a Licensee to demonstrate that:
- the Licensee and Relevant Activity are being directed and managed in the UAE;
- the relevant Core Income Generating Activities (CIGAs) are being conducted in the UAE; and
- the Licensee has adequate employees, premises and expenditure in the UAE. In addition to an annual notification requirement, Licensees that undertake and earn income from a Relevant Activity are also required to file an Economic Substance Return within 12 months from the end of the relevant financial period
The Regulations apply to financial years starting on or after 1 January 2019. Therefore, for a UAE company with 1 January 2019 - 31 December 2019 financial year, the first assessable period would be 1 January 2019 - 31 December 2019. For an UAE company with 1 April 2019 - 31 March 2020 financial year, the first assessable period would be 1 April 2019 - 31 March 2020.
Who is Subject to the Regulations?
Any business entity in the UAE carrying on a Relevant Activity is subject to ESR. Whether the entity is a foreign business or functioning in an offshore free zone is irrelevant if the activity carried on falls under the realm of Relevant Activity. Activities listed on the commercial license of an entity do not determine whether a Licensee undertakes a Relevant Activity. A ‘substance over form’ test is used to confirm whether an entity is carrying on a Relevant Activity and thus subject to ESR.
Licensees that are directly or indirectly at least 51% owned by the Federal or an Emirate Government, or a UAE Government body or authority, are exempt from the Regulations.
Steps to be taken by Licensees
Licensees must notify the Regulatory Authority of whether they are carrying out a relevant activity. If they are, the notification should include whether the gross income in relation to the relevant activity is subject to tax in a jurisdiction other than the UAE and the date of the end of its financial year. In addition to the notification, licensees carrying out a relevant activity are required to submit a report to the Regulatory Authority including the type of relevant activity conducted, amount and type of income, operating expenses, assets, and employee information.
This report must be submitted no later than 12 months after the last day of the end of each financial year commencing on or after 1 January 2019, in the form approved by the Regulatory Authority. Non-compliance may result in administrative penalties for failure to meet the economic substance test up to AED50,000 in the first financial period, and up to AED300,000 in subsequent financial periods), administrative penalties for failure to provide information (up to AED50,000), spontaneous exchange of information, and potentially deregistration.